Airmic

Insurance law reform

In the December edition Paul Jaffe and Alan Weir criticised Law Commission plans to make sweeping changes to UK insurance law. In this article, Law Commissioner David Hertzell says the proposals are overdue and popular with buyers.

We published our consultation paper in July, and have now received over 100 individual and group replies from all sides of the insurance market –insurers, buyers, brokers and lawyers.  We are looking at both consumer and business insurance, so it will take time to analyse the responses fully.

However, one thing is clear: many commercial buyers are far from happy about the current state of insurance law. One of our consultees – a very large international insurance buyer – told us that “over a certain amount I do not buy insurance – I buy a right to litigate”. His response is to put a lot more business into his captive, an approach that is also being adopted by his competitors.

Prisoners of history
Unfortunately we are prisoners of our history.The primary law of insurance, the Marine Insurance Act 1906, codified the nineteenth century “club rules” of the marine insurance market.  Judges have found it difficult to adapt the law around its unequivocal words.
But in 1906, many of today’s insurance products did not exist. The Act was never intended to apply to consumer insurance, or even to most general business insurance. Nor in 1906 was it possible to foresee a world of information technology and information overload.The Act has become increasingly anachronistic. It has had to be supplemented by a plethora of regulation and compensatory codes of practice, particularly for consumers. The danger of the industry’s reluctance to abandon a 1906 view of the world may be a negative effect on policyholder confidence.That might not be so apparent in specialist commercial markets, where the expertise of the London Market continues to command respect. However it is clear in, for example, the protection market, where critical illness sales are down and public cynicism is high, despite supportive regulation.

Freedom of contract
UK law is popular because it places very few restrictions on the agreements that large commercial parties may reach. Freedom of contract is also at the heart of our reforms.We propose that business buyers should be allowed to negotiate for any contract they wish – including reinstating the “prudent underwriter” test, if they like it.The only change will be in the default regime – that is the rules that apply in the absence of any specific agreement between the parties.

Risk adverse buyers
We thought that the main argument against our proposals would be that most market players would wish to
contract out of the default regime we suggest. Clearly, if there was widespread contracting-out, this could add to costs – the parties would have to spend time inserting terms that are currently unnecessary.

In fact, however, many insurers and buyers are saying the opposite: that very few buyers will want to sign a term replacing the “reasonable insured” test with a “prudent underwriter” test. In other words, we are told that most buyers will not want to agree that the underwriter may avoid the policy when the buyer acted reasonably.There is always a risk that information will not be passed on, even though the policyholder has been honest and careful. And most buyers are risk adverse – that is why they are buying insurance.It is therefore likely that most insureds will wish to pass the risk of innocent, reasonable non-disclosure to the insurer, even at the cost of a small increase in the premium. One trade
association has written to us to say;
“if that proves to be the case, so be it; more effective insurance arrangements should come at a price”.
If this is right – if most policyholders do want to buy cover against the small risk of an innocent and reasonable non-disclosure – shouldn’t insurers welcome the chance to provide their customers with the cover they want and the increased business that will follow?

Less certain than you might think
It is often said that the present law is certain, and any change will bring uncertainty. It is true that the 1906
Act has been around for a long time and has been subject to over 600
reported cases. But several large business buyers have told us that they find the current system uncertain.
One sophisticated insurance buyer in the transport industry said “(even as experienced market practitioners) we perhaps had not appreciated the full extent of the burden the law imposes on a purchaser of insurance”. Another wrote that “the current arrangements for insurance law are often little understood, resulting in unexpected… outcomes”. It is difficult to think of another sphere of commercial activity that supports so many litigation law firms.

One reason for uncertainty and repeated litigation is that the courts are increasingly struggling to do justice despite the Act, often at the cost of bending the words of the contract or the legislation.This is clearest where breaches of warranty are unconnected with the loss. Many insurers say they will not rely on an unconnected breach unless the policy is extremely carefully worded, because the courts are loath to uphold a stand seen as unfair.The courts frequently reach a fair result by re-interpreting the term, holding (for example) that the term was not really a warranty.

Under our proposals, it will still be possible to refuse a claim because of an unconnected breach of warranty –
but only if the parties have clearly addressed their mind to the issue when the contract was agreed. Paradoxically, this may make it easier for insurers to take the point.The courts will no longer be struggling with anachronistic and unfair legislation, but will only apply the rules the parties agreed to.

Increasing due diligence?
The third argument for the current system is that it allows insurance to be placed quickly, cheaply and without much thought.That may be right -unlike banking, the cost is pushed back to the claim stage.

In most of the case histories brought to our attention, so many problems could have been avoided if the insurer had asked some simple questions. In contract frustration insurance, for example, it would be easy for the underwriters to ask whether the insured had any reason to think that the project would not generate the anticipated revenues. Under our regime, if an underwriter asks the question, and the policyholder then fails to do a full search of the information available to them, the insurer will be fully protected.

Our proposals may involve insurers asking a few more questions, or (if they do not) encouraging their policyholders to agree to more restrictive terms. However, we think this will have real advantages.
Policyholders are more likely to give the right information.“Information dumping” will be reduced. And greater perceived fairness at the underwriting stage will also allow insurers to take the moral high ground against dishonesty and negligence.

It is unlikely that most areas of insurance will experience increased costs.The PWC report commissioned by the ABI shows any cost increases to be limited in both amount and in the classes of business affected.The PWC report overstates even these limited costs. Unfortunately, it was based on the Law Commissions’ Issue Papers and not the Consultation Paper, which contain several revised proposals designed to limit cost increases.

Next steps
Our proposals were not produced in a vacuum.They represent what we were told was existing best practice.We must now consider the responses carefully, and adapt them in the light of what the market is telling us.